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Why SocGen Is Very Nervous About The Recent Loss Of $9 Trillion In Global Market Cap

The good news: the collapse in global market cap since May of 2015 is not the worst ever.

The bad news: the $9 trillion drop in combined market cap between the MSCI All World index and Chinese stocks, is the second highest ever, surpassed only by the $13 plunge in global market capitalization in late 2008.

Wait, $9 trillion? Yes: for all the focus on the modest correction in the S&P500, what most have forgotten is that in addition to the US, various other development markets, not to mention emerging markets, have lost trillions and trillions in value since their May peaks. According to SocGen calculations, there has been a $1 trillion drop in emerging markets, a $4 trillion decline in development equity markets, and let's not forget, the bursting of the Chinese stock bubble, which from a peak market capitalization of $10 trillion in early June, or about the same as China's GDP, has lost some $4 trillion, since despite the Chinese government's increasingly more desperate and futile attempts to reflate the bubble.

Combining all this, SocGen summarizes, "we are looking at an overall $US9 trillion loss of market capitalisation in less than 3 months! To put that number in context the most severe loss in market capitalisation over 3 months during the 2008/09 financial crisis was $12.8 trillion." The drop is almost the same as China's $10 trillion GDP (and likely well higher if one uses credible calculations).

But that's not the worst news. As SocGen's Andrew Lapthorne suggests, "such a decline in market values will impact implied leverage calculations and as such all eyes should now be on credit markets. Asian credit is already reacting to the price declines, with the likes of the Markit iTraxx Asia ex Japan CDS index moving significantly wider. However there has, as yet been no significant de-rating of credit in the likes of the US."

Worse, as Lapthorne showed a few weeks ago when he documented that despite the price drop, EV/EBITDA ratios still remain extremely elevated...

... the drop in the market capitalization, and thus enterprise value (aka the EV used in the EV/EBITDA calculation) with debt sticky, will lead to far higher gross leverage ratios. To be sure, the $2 trillion in total debt (and $1 trillion in net debt) added to the balance sheets of non-financial firms since 2009 will not help. In fact, if the market suddenly realizes just how overlevered US firms are, now that the Fed is set to begin hiking rates and pushing interest rates higher, something just may snap in the bond market which has been extremely generous to corporate CFOs in the past 7 years.

Lapthorne's conclusion...

US corporates also have an insatiable appetite for more debt, with non-financials raising a further $450bn over the past year, according to their latest report and accounts. Why do they need to borrow so much? Well to buy back their own market capitalisation of course!

... reminds us that any day now the old Baron Munchausen trick of pulling yourself up by your bootstraps, i.e., issuing debt to push up your equity value, will no longer work.

Should the biggest buyer of stocks in the past several years - corporations themselves using buybacks - disappear from the bid side, then there is only one possible source of end-demand for risk we can think of...